us internal revenue service: irb04-18

8/14/2019 US Internal Revenue Service: irb04-18

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Bulletin No. 2004-1May 3, 200

HIGHLIGHTS

OF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 200443, page 842.Partnership mergers. This ruling describes the applicationof sections 704(c)(1)(B) and 737 of the Code to assets-overpartnership mergers. The ruling holds that section 704(c)(1)(B)applies to newly created section 704(c) gain or loss in prop-

erty contributed by the transferor partnership to the continuingpartnership in an assets-over partnership merger, but does notapply to newly created reverse section 704(c) gain or loss re-sulting from a revaluation of property in the continuing partner-ship. The ruling also holds that for purposes of section 737(b),net precontribution gain includes newly created section 704(c)gain or loss in property contributed by the transferor partner-ship to the continuing partnership in an assets-over partnershipmerger, but does not include newly created reverse section704(c) gain or loss resulting from a revaluation of property inthe continuing partnership.

REG10668102, page 852.

Proposed regulations under section 856 of the Code clarifythat an entity that is disregarded as separate from its owner, aqualified REIT subsidiary, or a qualified subchapter S subsidiaryis treated as an entity separate from its owner if the entity isliable for federal taxes. A public hearing is scheduled for July22, 2004.

EMPLOYEE PLANS

Notice 200432, page 847.

Weighted average interest rate update. The weighted av-erage interest rate for April 2004 and the resulting permissible

range of interest rates used to calculate current liability and determine the required contribution are set forth.

Notice 200434, page 848.Minimum funding standards; interest rates; section 10of Pension Funding Equity Act. This notice describes tmethod for determining the permissible range of interest rat

for current liability under section 412 of the Code as amendby section 101 of the Pension Funding Equity Act of 2004.addition, comments are requested on this notice.

Announcement 200432, page 860.Employee Plans determination letter program; individally designed plans. This announcement describes the Svices decisions resulting from its review of comments followithe issuance of two white papers on the future of the EmployPlans determination letter program.

Announcement 200433, page 862.Pre-approved employee plans; proposed revenue proc

dure; request for comments. This announcement describand contains a draft proposed revenue procedure pertaining those employee plans (master and prototype (M&P) and volumsubmitter (VS)) that are pre-approved by the Service. Portioof the draft procedure are reserved pending comments.

Announcement 200438, page 878.Minimum funding standards; alternative deficit redution election. This announcement describes how an electito make an alternative deficit reduction contribution under setion 412(l) of the Code may be made and describes some the background to that election.

(Continued on the next pag

Finding Lists begin on page ii.


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EXEMPT ORGANIZATIONS

Announcement 200431, page 854.A list is provided of organizations now classified as private foun-dations.

Announcement 200441, page 879.Kids Voting SD of Rapid City, SD, no longer qualifies as an or-

ganization to which contributions are deductible under section170 of the Code.

ADMINISTRATIVE

Rev. Rul. 200441, page 845.Limited Liability Company. This ruling discusses the issueof whether the IRS can collect employment taxes owed by amulti-member domestic Limited Liability Company (LLC) fromthe members.

REG10668102, page 852.Proposed regulations under section 856 of the Code clarifythat an entity that is disregarded as separate from its owner, aqualified REIT subsidiary, or a qualified subchapter S subsidiaryis treated as an entity separate from its owner if the entity isliable for federal taxes. A public hearing is scheduled for July22, 2004.

Notice 200433, page 847.Credit for sales of fuel produced from a nonconventionalsource, inflation adjustment factor, and reference price.This notice publishes the nonconventional source fuel credit,the inflation adjustment factor, and the reference price under

section 29 of the Code for calendar year 2003. This data isused to determine the credit allowable on sales of fuel pro-duced from a nonconventional source.

May 3, 2004 2004-18 I.R.B.


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The IRS Mission

Provide Americas taxpayers top quality service by helpingthem understand and meet their tax responsibilities and by

applying the tax law with integrity and fairness to all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly and may be obtained from theSuperintendent of Documents on a subscription basis. Bulletincontents are compiled semiannually into Cumulative Bulletins,which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-

stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke, mod-ify, or amend any of those previously published in the Bulletin.All published rulings apply retroactively unless otherwise indi-cated. Procedures relating solely to matters of internal man-agement are not published; however, statements of internalpractices and procedures that affect the rights and duties oftaxpayers are published.

Revenue rulings represent the conclusions of the Service on theapplication of the law to the pivotal facts stated in the revenueruling. In those based on positions taken in rulings to taxpayersor technical advice to Service field offices, identifying detailsand information of a confidential nature are deleted to preventunwarranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not berelied on, used, or cited as precedents by Service personnel inthe disposition of other cases. In applying published rulings andprocedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be considereand Service personnel and others concerned are cautionagainst reaching the same conclusions in other cases unlethe facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.1986 Code.This part includes rulings and decisions based on provisions the Internal Revenue Code of 1986.

Part II.Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart Tax Conventions and Other Related Items, and Subpart B, Leislation and Related Committee Reports.

Part III.Administrative, Procedural, and MiscellaneouTo the extent practicable, pertinent cross references to thesubjects are contained in the other Parts and Subparts. Alincluded in this part are Bank Secrecy Act Administrative Rings. Bank Secrecy Act Administrative Rulings are issued the Department of the Treasurys Office of the Assistant Se

retary (Enforcement).

Part IV.Items of General Interest.This part includes notices of proposed rulemakings, disbment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative indfor the matters published during the preceding months. Themonthly indexes are cumulated on a semiannual basis, and apublished in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropria

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

2004-18 I.R.B. May 3, 200


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Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 704.PartnersDistributive Share

26 CFR 1.7043: Contributed property.

(Also: 708, 737, 1.7041, 1.7043, 1.7044,

1.7081, 1.7371, 1.7372, 1.7373.)

Partnership mergers. This ruling

describes the application of sections

704(c)(1)(B) and 737 of the Code to as-

sets-over partnership mergers. The ruling

holds that section 704(c)(1)(B) applies to

newly created section 704(c) gain or loss

in property contributed by the transferor

partnership to the continuing partnership

in an assets-over partnership merger, but

does not apply to newly created reverse

section 704(c) gain or loss resulting from

a revaluation of property in the continuing

partnership. The ruling also holds that

for purposes of section 737(b), net pre-

contribution gain includes newly created

section 704(c) gain or loss in property con-

tributed by the transferor partnership to the

continuing partnership in an assets-over

partnership merger, but does not include

newly created reverse section 704(c) gain

or loss resulting from a revaluation of

property in the continuing partnership.

Rev. Rul. 200443

ISSUES

1) Does 704(c)(1)(B) of the Internal

Revenue Code apply to 704(c) gain or

loss that is created in an assets-over part-

nership merger?

2) For purposes of 737(b), does net

precontribution gain include 704(c) gain

or loss that is created in an assets-over part-

nership merger?

FACTS

Situation 1. On January 1, 2004, A con-

tributes Asset 1, with a basis of $200x and

a fair market value of $300x to partnership

AB in exchange for a 50 percent interest.

On the same date, B contributes $300x of

cash to AB in exchange for a 50 percent

interest. Also on January 1, 2004, C con-

tributes Asset 2, with a basis of $100x and

a fair market value of $200x to partnership

CD in exchange for a 50 percent interest.

D contributes $200x of cash to CD in ex-

change for a 50 percent interest.

On January 1, 2006, AB and CD under-

take an assets-over partnership merger in

whichAB is the continuing partnership and

CD is the terminating partnership. At thetime of the merger, ABs only assets are

Asset 1, with a fair market value of $900x,

and $300x in cash, and CDs only assets

are Asset 2, with a fair market value of

$600x and $200x in cash. After the merger,

the partners have capital and profits inter-

ests in AB as follows: A, 30 percent; B, 30

percent; C, 20 percent; and D, 20 percent.

The partnership agreements forAB and

CD provide that the partners capital ac-

counts will be determined and maintained

in accordance with 1.7041(b)(2)(iv)

of the Income Tax Regulations, distri-

butions in liquidation of the partnership

(or any partners interest) will be made

in accordance with the partners positive

capital account balances, and any part-

ner with a deficit balance in the partners

capital account following the liquidation

of the partners interest must restore that

deficit to the partnership (as set forth in

1.7041(b)(2)(ii)(b)(2) and (3)). AB and

CD both have provisions in their partner-

ship agreements requiring the revaluation

of partnership property upon the entry ofa new partner. AB would not be treated

as an investment company (within the

meaning of 351) if it were incorporated.

Neither partnership holds any unrealized

receivables or inventory for purposes of

751. AB and CD do not have a 754

election in place. Asset 1 and Asset 2 are

nondepreciable capital assets.

On January 1, 2012, AB has the same

assets that it had after the merger. Each as-

set has the same value that it had at the time

of the merger. On this date, AB distributes

Asset 2 to A in liquidation of As interestin AB.

Situation 2. The facts are the same as

in Situation 1, except that on January 1,

2012, Asset 1 has a value of $275x, and

AB distributes Asset 1 to C in liquidation

of Cs interest in AB.

LAW

Under 704(b) and the regulation

thereunder, allocations of a partnership

items of income, gain, loss, deduction

or credit provided for in the partnershiagreement will be respected if the allo

cations have substantial economic effect

Allocations that fail to have substantia

economic effect will be reallocated ac

cording to the partners interests in th

partnership.

Section 1.7041(b)(2)(iv)(f) provide

that a partnership may, upon the occur

rence of certain events (including th

contribution of money to the partnership

by a new or existing partner), increas

or decrease the partners capital account

to reflect a revaluation of the partnershiproperty.

Section 1.7041(b)(2)(iv)(g) provide

that, to the extent a partnerships propert

is reflected on the books of the partnershi

at a book value that differs from the ad

justed tax basis, the substantial economi

effect requirements apply to the alloca

tions of book items. Section 704(c) an

1.7041(b)(4)(i) govern the partners

distributive shares of tax items.

Section 1.7041(b)(4)(i) provide

that if partnership property is, unde

1.7041(b)(2)(iv)(f), properly reflecte

in the capital accounts of the partners an

on the books of the partnership at a book

value that differs from the adjusted tax ba

sis of the property, then depreciation, de

pletion, amortization, and gain or loss, a

computed for book purposes, with respec

to the property will be greater or less than

the depreciation, depletion, amortization

and gain or loss, as computed for federa

tax purposes, with respect to the property

In these cases the capital accounts of th

partners are required to be adjusted solelyfor allocations of the book items to th

partners (see 1.7041(b)(2)(iv)(g)), an

the partners shares of the correspondin

tax items are not independently reflecte

by further adjustments to the partners cap

ital accounts. Thus, separate allocation

of these tax items cannot have economi

effect under 1.7041(b)(2)(ii)(b)(1), an

the partners distributive shares of ta

items must (unless governed by 704(c)

2004-18 I.R.B. 842 May 3, 200


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be determined in accordance with the part-

ners interests in the partnership. These

tax items must be shared among the part-

ners in a manner that takes account of the

variation between the adjusted tax basis of

the property and its book value in the same

manner as variations between the adjusted

tax basis and fair market value of property

contributed to the partnership are taken

into account in determining the partners

shares of tax items under 704(c).

Section 704(c)(1)(A) provides that in-

come, gain, loss, and deduction with re-

spect to property contributed to the part-

nership by a partner shall be shared among

the partners so as to take account of the

variation between the basis of the property

to the partnership and its fair market value

at the time of contribution.

Section 1.7043(a)(2) provides that,

except as provided in 1.7043(e)(2) and

(3), 704(c) and 1.7043 apply on aproperty-by-property basis.

Section 1.7043(a)(3)(i) provides that

property contributed to a partnership is

704(c) property if at the time of contri-

bution its book value differs from the con-

tributing partners adjusted tax basis. For

purposes of 1.7043, book value is de-

termined as contemplated by 1.7041(b).

Therefore, book value is equal to fair mar-

ket value at the time of contribution and

is subsequently adjusted for cost recovery

and other events that affect the basis of the

property.Section 1.7043(a)(3)(ii) provides that

the built-in gain on 704(c) property is the

excess of the propertys book value over

the contributing partners adjusted tax ba-

sis upon contribution. The built-in gain is

thereafter reduced by decreases in the dif-

ference between the propertys book value

and adjusted tax basis.

Section 1.7043(a)(6) provides that the

principles of 1.7043 also apply to re-

verse 704(c) allocations which result

from revaluations of partnership property

pursuant to 1.7041(b)(2)(iv)(f).Section 1.7043(a)(7) provides that, if a

contributing partner transfers a partnership

interest, built-in gain or loss must be allo-

cated to the transferee partner as it would

have been allocated to the transferor part-

ner. If the contributing partner transfers

a portion of the partnership interest, the

share of built-in gain or loss proportionate

to the interest transferred must be allocated

to the transferee partner.

Section 704(c)(1)(B) provides that if

any property contributed to the partnership

by a partner is distributed (directly or indi-

rectly) by the partnership (other than to the

contributing partner) within seven years

of being contributed: (i) the contributing

partner shall be treated as recognizing gain

or loss (as the case may be) from the sale

of the property in an amount equal to the

gain or loss which would have been allo-

cated to the partner under 704(c)(1)(A)

by reason of the variation described in

704(c)(1)(A) if the property had been

sold at its fair market value at the time of

the distribution; (ii) the character of the

gain or loss shall be determined by refer-

ence to the character of the gain or loss

which would have resulted if the property

had been sold by the partnership to the dis-

tributee; and (iii) appropriate adjustments

shall be made to the adjusted basis of the

contributing partners interest in the part-nership and to the adjusted basis of the

property distributed to reflect any gain or

loss recognized under 704(c)(1)(B).

Section 1.7044(c)(4) provides that

704(c)(1)(B) and 1.7044 do not apply

to a transfer by a partnership (transferor

partnership) of all of its assets and liabil-

ities to a second partnership (transferee

partnership) in an exchange described in

721, followed by a distribution of the

interest in the transferee partnership in

liquidation of the transferor partnership

as part of the same plan or arrangement.Section 1.7044(c)(4) also provides that a

subsequent distribution of 704(c) prop-

erty by the transferee partnership to a

partner of the transferee partnership is

subject to 704(c)(1)(B) to the same ex-

tent that a distribution by the transferor

partnership would have been subject to

704(c)(1)(B).

Section 1.7044(d)(2) provides that the

transferee of all or a portion of the part-

nership interest of a contributing partner is

treated as the contributing partner for pur-

poses of 704(c)(1)(B) and 1.7044 tothe extent of the share of built-in gain or

loss allocated to the transferee partner.

Section 708(a) provides that, for pur-

poses of subchapter K, an existing partner-

ship shall be considered as continuing if it

is not terminated.

Section 708(b)(2)(A) provides that in

the case of the merger or consolidation

of two or more partnerships, the resulting

partnership shall, for purposes of 708, be

considered the continuation of any merg-

ing or consolidating partnership whose

members own an interest of more than 50

percent in the capital and profits of the

resulting partnership.

Section 1.7081(c)(3)(i) provides that

when two or more partnerships merge or

consolidate into one partnership under the

applicable jurisdictional law without un-

dertaking a form for the merger or consol-

idation, or undertake a form for the merger

or consolidation that is not described in

1.7081(c)(3)(ii), any merged or consol-

idated partnership that is considered ter-

minated under 1.7081(c)(1) is treated

as undertaking the assets-over form for

federal income tax purposes. Under the

assets-over form, the merged or consoli-

dated partnership that is considered termi-

nated under 1.7081(c)(1) contributes all

of its assets and liabilities to the resulting

partnership in exchange for an interest inthe resulting partnership, and immediately

thereafter, the terminated partnership dis-

tributes interests in the resulting partner-

ship to its partners in liquidation of the ter-

minated partnership.

Section 737(a) provides that, in the case

of any distribution by a partnership to a

partner, the partner shall be treated as rec-

ognizing gain in an amount equal to the

lesser of (1) the excess (if any) of (A) the

fair market value of property (other than

money) received in the distribution over

(B) the adjusted basis of the partners in-terest in the partnership immediately be-

fore the distribution reduced (but not be-

low zero) by the amount of money re-

ceived in the distribution, or (2)the net pre-

contribution gain of the partner. Gain rec-

ognized under the preceding sentence shall

be in addition to any gain recognized un-

der 731. The character of the gain shall

be determined by reference to the propor-

tionate character of the net precontribution

gain.

Section 737(b) provides that for pur-

poses of 737, the term net precontri-bution gain means the net gain (if any)

which would have been recognized by the

distributee partner under 704(c)(1)(B)

if all property which (1) had been con-

tributed to the partnership by the distribu-

tee partner within seven years of the dis-

tribution, and (2) is held by the partner-

ship immediately before the distribution,

had been distributed by the partnership to

another partner.

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Section 1.7371(c)(1) provides that the

distributee partners net precontribution

gain is the net gain (if any) that would have

been recognized by the distributee partner

under 704(c)(1)(B) and 1.7044 if

all property that had been contributed to

the partnership by the distributee partner

within seven years of the distribution and

is held by the partnership immediately be-

fore the distribution had been distributed

by the partnership to another partner other

than a partner who owns, directly or indi-

rectly, more than 50 percent of the capital

or profits interest in the partnership.

Section 1.7371(c)(2)(iii) provides that

the transferee of all or a portion of a con-

tributing partners partnership interest suc-

ceeds to the transferors net precontribu-

tion gain, if any, in an amount proportion-

ate to the interest transferred.

Section 1.7372(b)(1) provides that

737 and 1.7372 do not apply to atransfer by a partnership (transferor part-

nership) of all of its assets and liabilities to

a second partnership (transferee partner-

ship) in an exchange described in 721,

followed by a distribution of the interest

in the transferee partnership in liquidation

of the transferor partnership as part of the

same plan or arrangement.

Section 1.7372(b)(3) provides that a

subsequent distribution of property by the

transferee partnership to a partner of the

transferee partnership that was formerly a

partner of the transferor partnership is subject to 737 to the same extent that a

distribution from the transferor partnership

would have been subject to 737.

ANALYSIS

Section 1.7044(c)(4) describes the ef-

fect of an assets-over partnership merger

on pre-existing 704(c) gain or loss

for purposes of 704(c)(1)(B). Un-

der 1.7044(c)(4), if the transferor

partnership in an assets-over merger

holds contributed property with 704(c)

gain or loss, the seven year period in

704(c)(1)(B) does not restart with re-

spect to that gain or loss as a result of the

merger. Section 1.7044(c)(4) does not

prevent the creation of new 704(c) gain

or loss when assets are contributed by one

partnership to another partnership in an

assets-over merger. Section 704(c)(1)(B)

applies to this newly created 704(c)

gain or loss if the assets contributed in the

merger are distributed to a partner other

than the contributing partner (or its suc-

cessor) within seven years of the merger.

Section 1.7372(b)(1) and (3) describes

the effect of an assets-over partnership

merger on net precontribution gain that

includes pre-existing 704(c) gain or loss.Under 1.7372(b)(3), if the transferor

partnership in an assets-over merger holds

contributed property with 704(c) gain

or loss, the seven year period in 737(b)

does not restart with respect to that gain

or loss as a result of the merger. Section

1.7372(b)(3) does not prevent the cre-

ation of new 704(c) gain or loss when

assets are contributed by one partnership

to another partnership in an assets-over

merger. This gain or loss must be con-

sidered in determining the amount of net

precontribution gain for purposes of 737if the continuing partnership distributes

other property to the contributing partner

(or its successor) within seven years of the

merger.

Section 1.7043(a)(6)(i) provides that

the principles of 1.7043 apply to reverse

704(c) allocations. In contrast, the reg-

ulations under 704(c)(1)(B) and 737

contain no similar rule requiring that th

principles of 704(c)(1)(B) and 737 ap

ply to reverse 704(c) allocations. Un

der those regulations, 704(c)(1)(B) an

737 do not apply to reverse 704(c) al

locations.

In both of the situations describe

above, on the date of the partnershi

merger, CD contributes cash and Asset

to AB in exchange for an interest in AB

Immediately thereafter, CD distributes, i

liquidation, interests in AB to Cand D. As

set 2 has a basis of $100x and a fair marke

value of $600x upon contribution. Of th

$500x of built in gain in Asset 2, $100

is pre-existing 704(c) gain attributabl

to Cs contribution of Asset 2 to CD, an

$400x is additional 704(c) gain create

as a result of the merger. As the transferee

of CDs partnership interest in AB, C an

D each succeed to one-half ofCDs $400

of 704(c) gain in Asset 2 (each $200x)Section 1.7043(a)(7). Thus, Cs share o

704(c) gain is $300x, and Ds share o

704(c) gain is $200x.

The entry ofCD as a new partner ofAB

causes partnership AB to revalue its prop

erty. When CD enters as a new partner o

AB, Asset 1 has a basis of $200x and a fai

market value of $900x. Of the $700x o

built-in gain in Asset 1, $100x is pre-exist

ing 704(c) gain attributable to the con

tribution of Asset 1 by A. The revaluatio

results in the creation of $600x of revers

704(c) gain in Asset 1. This layer of reverse 704(c) gain is shared equally by A

and B ($300x each). Thus, As share o

704(c) gain is $400x, and Bs share o

704(c) gain is $300x. The calculation o

704(c) gain in each asset is summarize

in the following table.

Adjusted

Tax Basis

Value onDate of

Contribution

704(c)

Gain onDate of

Contribution

Value onDate of

Merger

704(c)

Gain

Createdby

Merger

Total

704(c)

GainAfter

Merger

Asset 1 $200x $300x $100x $900x $600x $700x

Asset 2 $100x $200x $100x $600x $400x $500x

Cash $500x $500x $0x $500x $0x $0x

Total $800x $1,000x $200x $2,000x $1,000x $1,200x

2004-18 I.R.B. 844 May 3, 200


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The partners share of 704(c) gain in

each ofABs assets after themerger is sum-

marized in the following table.

As Share of

704(c)

Gain

Bs Share of

704(c)

Gain

Cs Share of

704(c)

Gain

Ds Share of

704(c)

Gain

Total

704(c)

Gain

Asset 1 $400x $300x $0x $0x $700xAsset 2 $0x $0x $300x $200x $500x

Cash $0x $0x $0x $0x $0x

Total $400x $300x $300x $200x $1,200x

In Situation 1, the distribution of As-

set 2 to A occurs more than seven years

after the contribution of Asset 2 to CD.

Therefore, 704(c)(1)(B) does not apply

to the $100x of pre-existing 704(c) gain

attributable to that contribution. How-

ever, the distribution of Asset 2 to A oc-

curs within seven years of the contribu-

tion of Asset 2 by CD to AB. The con-

tribution of Asset 2 by CD to AB creates

704(c) gain of $400x. As the transferees

of CDs partnership interest in AB, C and

D each succeed to one-half of the $400x of

704(c) gain created by the merger. Sec-

tion 1.7043(a)(7). Section 704(c)(1)(B)

applies to that 704(c) gain, causing Cand

D each to recognize $200x of gain.

The distribution of Asset 2 to A occurs

more than seven years after the contribu-

tionof Asset 1 toAB,andA made no subse-quent contributions to AB. Therefore, As

net precontribution gain for purposes of

737(b) at the time of the distribution is

zero. ABs $600x of reverse 704(c) gain

in Asset 1, resulting from a revaluation of

ABs partnership property at the time of

the merger, is not net precontribution gain.

Accordingly, A will not recognize gain un-

der 737 as a result of the distribution of

Asset 2.

In Situation 2, 704(c)(1)(B) does not

apply to the distribution by the continuing

partnership of Asset 1 to C on January 1,2012. The distribution of Asset 1 to Coc-

curs more than seven years after the contri-

bution of Asset 1 toAB, and 704(c)(1)(B)

does not apply to the reverse 704(c) gain

in Asset 1 resulting from a revaluation of

ABs partnership property at the time of the

merger. Accordingly, neitherA nor B will

recognize gain under 704(c)(1)(B) as a

result of the distribution of Asset 1 to C.

The distribution of Asset 1 to C occurs

more than seven years after the contribu-

tion of Asset 2 to CD. Therefore, Cs net

precontribution gain at the time of the dis-

tribution does not include Cs $100x of

pre-existing 704(c) gain attributable to

that contribution. However, the distribu-

tion of Asset 1 to C occurs within seven

years of the contribution of Asset 2 by

CD to AB. The contribution of Asset 2

by CD to AB creates net precontribution

gain of $400x. As the transferees ofCDs

partnership interest in AB, C and D each

succeed to one-half of CDs $400x of net

precontribution gain in Asset 2. Section

1.7371(c)(2)(iii). Thus, Cs portion of

CDs net precontribution gain created by

the merger is $200x. The excess of Asset

1s fair market value, $275x, over the ad-

justed tax basis of Cs interest in AB im-mediately before the distribution, $100x,

is $175x, which is less than Cs $200x

of net precontribution gain. Therefore, C

will recognize $175x of capital gain un-

der 737 as a result of the distribution.

Because no property is distributed to D

and none of the property treated as con-

tributed by D is distributed to another part-

ner, D recognizes no gain under 737 or

704(c)(1)(B).

HOLDINGS

1) Section 704(c)(1)(B) applies to

newly created 704(c) gain or loss in

property contributed by the transferor

partnership to the continuing partnership

in an assets-over partnership merger, but

does not apply to newly created reverse

704(c) gain or loss resulting from a

revaluation of property in the continuing

partnership.

2) For purposes of 737(b), net pre-

contribution gain includes newly created

704(c) gain or loss in property con-

tributed by the transferor partnership to the

continuing partnership in an assets-over

partnership merger, but does not include

newly created reverse 704(c) gain or loss

resulting from a revaluation of property in

the continuing partnership.

DRAFTING INFORMATION

The principal author of this revenue

ruling is Heather Faught of the Associate

Chief Counsel (Passthroughs and Spe-

cial Industries). For further information

regarding this revenue ruling, contact

Heather Faught at (202) 6223060 (not a

toll-free call).

Section 708.Continuationof Partnership

A revenue ruling describes the application of sec-

tion 704(c)(1)(B) and section 737 to assets-over part-

nership mergers. See Rev. Rul. 2004-43, page 842.

Section 737.Recognitionof Precontribution Gainin Case of CertainDistributions to ContributingPartner

A revenue ruling describes the application of sec-

tion 704(c)(1)(B) and section 737 to assets-over part-

nership mergers. See Rev. Rul. 2004-43, page 842.

Section 6331.Levyand Distraint

26 CFR 301.63311: Levy and distraint.

Limited Liability Company. This rul-

ing discusses the issue of whether the IRS

May 3, 2004 845 2004-18 I.R.B.


8/47

can collect employment taxes owed by a

multi-member domestic Limited Liability

Company (LLC) from the members.

Rev. Rul. 200441

ISSUE

When a multi-member domestic Lim-

ited Liability Company (LLC) incursfederal employment tax liabilities, can the

IRS collect the employment taxes owed by

the LLC from the members, including by

levy on the members property and rights

to property?

BACKGROUND

A multi-member domestic LLC is an el-

igible entity that may be, and by default

is, classified as a partnership for federal

tax purposes under Section 301.77011 et.

seq. of the Procedure and AdministrationRegulations. For states that permit LLCs,

state law generally provides that the mem-

bers of an LLC are not liable for the debts

of the LLC in their capacity as members of

the LLC, subject to certain limited excep-

tions. Questions have arisen as to whether

classification of an LLC as a partnership

for federal tax law purposes permits the

IRS to collect federal employment tax lia-

bilities of the LLC from the LLC members

as if they were general partners of a part-

nership.

FACTS

X, Y, and Z are the members of a do-

mestic LLC (XYZ) formed in state A.

XYZ is an employer for federal tax pur-

poses and has incurred a federal employ-

ment tax liability that remains unpaid. X,

Y, and Z have assets that would be suffi-

cient to satisfy all or a portion of the em-

ployment tax liability. Under the laws of

state A, the members of an LLC generally

are not liable for the debts of the LLC.

LAW AND ANALYSIS

State law generally provides that the

general partners of a partnership are jointly

and severally liable for the partnerships

obligations. With respect to federal tax li-

abilities incurred by a partnership, such as

federal employmenttaxes, the Service may

seek to collect those federal tax liabilities

from the general partners of the partner-

ship. See United States v. Papandon, 331

F.3d 52, 5556 (2d Cir. 2003) (state law

determines a partners liability for partner-

ship obligations, including federal tax lia-

bilities); Remington v. United States, 210F.3d 281, 283 (5th Cir. 2000) (Accord-

ingly, under Texas law, the IRS is entitled

to collect the trust fund tax liability, indis-

putably a partnership debt, from any one of

the general partners ....); see also United

States v. Galletti, 72 U.S.L.W. 4252 (U.S.

March 23, 2004). In contrast, an LLC

member generally is not liable under state

law for the LLCs debts. E.g., N.Y. Ltd.

Liab. Co. Law 609(a) (McKinney Supp.

2003). Thus, the Service, as a general

matter, cannot collect the LLCs employ-

ment tax liability from the LLC members.

Therefore, because the members, X, Y, and

Z, are not liable under the law of state A for

the debts of XYZ, the IRS may not levy

on the property and rights to property of

the members, in their capacity as members

to collect the employment taxes owed b

XYZ.

There, however, may be special cir

cumstances such as a fraudulent transfe

of assets from the LLC to its member

which might expose the members to liabil

ity. See generally Scott v. Commissione

236 F.3d 1239 (10th Cir. 2001) (impos

ing transferee liability under I.R.C. 690

on person receiving fraudulent transfer o

assets from taxpayer-corporation); Stank

v. Commissioner, 209 F.3d 1082 (8th Cir

2000) (same). Also, dependingon thefact

of a particular case, a member may be li

able for the trust fund recovery penalty un

der I.R.C. 6672.

HOLDING

If under state law the members of th

LLC are not liable for the debts of th

LLC, then absent fraudulent transfers o

other special circumstances, the IRS ma

not collect the LLCs employment tax lia

bility from the members, including by lev

on the property and rights to property o

the members.


The principal author of this revenu

ruling is Walter Ryan of the Office of th

Associate Chief Counsel, Procedure an

Administration (Collection, Bankruptc

& Summonses Division). For further in

formation regarding this revenue ruling

contact Branch 1 of the Collection, Bank

ruptcy & Summonses Division at (202

6223610 (not a toll-free call).

2004-18 I.R.B. 846 May 3, 200


9/47

Part III. Administrative, Procedural, and Miscellaneous

Weighted Average InterestRate Update

Notice 200432

Sections 412(b)(5)(B) and 412(l)(7)

(C)(i) of the Internal Revenue Code pro-vide that the interest rates used to calculate

current liability and to determine the re-

quired contribution under 412(l) must

be within a permissible range around the

weighted average of the rates of interest

on 30-year Treasury securities during the

four-year period ending on the last day

before the beginning of the plan year.

Notice 8873, 19882 C.B. 383, pro-

vides guidelines for determining the

weighted average interest rate and the

resulting permissible range of interest

rates used to calculate current liability.

Section 417(e)(3)(A)(ii)(II) of the Code

defines the applicable interest rate, whichmust be used for purposes of determining

the minimum present value of a partici-

pants benefit under 417(e)(1) and (2),

as the annual rate of interest on 30-year

Treasury securities for the month before

the date of distribution or such other time

as the Secretary may by regulations pre-

scribe. Section 1.417(e)1(d)(3) of the In-

come Tax Regulations provides that theap-

plicable interest rate for a month is the an-

nual interest rate on 30-year Treasury se-

curities as specified by the Commissioner

for that month in revenue rulings, notices

or other guidance published in the Internal

Revenue Bulletin.

The rate of interest on 30-year TreasurySecurities for March 2004 is 4.74 percent.

Pursuant to Notice 200226, 20021 C.B.

743, the Service has determined this rate

as the monthly average of the daily deter-

mination of yield on the 30-year Treasury

bond maturing in February 2031.

The following rates were determined

for the plan years beginning in the month

shown below.

Month Year WeightedAverage

90% to 105%

PermissibleRange

90% to 110%

PermissibleRange

April 2004 5.18 4.67 to 5.44 4.67 to 5.70

Drafting Information

The principal authors of this notice

are Paul Stern and Tony Montanaro of

the Employee Plans, Tax Exempt and

Government Entities Division. For fur-

ther information regarding this notice,

please contact the Employee Plans tax-

payer assistance telephone service at18778295500 (a toll-free number),

between the hours of 8:00 a.m. and

6:30 p.m. Eastern time, Monday through

Friday. Mr. Stern may be reached at

12022839703. Mr. Montanaro may

be reached at 12022839714. The tele-

phone numbers in the preceding sentences

are not toll-free.

Nonconventional Source FuelCredit, Section 29 Inflation

Adjustment Factor, andSection 29 Reference Price

Notice 200433

This notice publishes the nonconven-

tional source fuel credit, inflation adjust-

ment factor, and reference price under 29

of the Internal Revenue Code for calen-

dar year 2003. These are used to deter-

mine the credit allowable on fuel produced

from a nonconventional source under 29.

The calendar year 2003 inflation-adjusted

credit applies to the sales of barrel-of-oil

equivalent of qualified fuels sold by a tax-

payer to an unrelated person during the

2003 calendar year, the domestic produc-

tion of which is attributable to the taxpayer.

BACKGROUND

Section 29(a) provides for a credit for

producing fuel from a nonconventional

source, measured in barrel-of-oil equiva-

lent of qualified fuels, the production of

which is attributable to the taxpayer and

sold by the taxpayer to an unrelated person

during the tax year. The credit is equal to

the product of $3.00 and the appropriate

inflation adjustment factor.

Section 29(b)(1) and (2) provides for

a phaseout of the credit. The credit al-

lowable under 29(a) must be reduced by

an amount which bears the same ratio to

the amount of the credit (determined with-

out regard to 29(b)(1)) as the amount

by which the reference price for the cal-

endar year in which the sale occurs ex-

ceeds $23.50 bears to $6.00. The $3.00 in

29(a) and the $23.50 and $6.00 must each

be adjusted by multiplying these amounts

by the 2003 inflation adjustment factor. In

the case of gas from a tight formation, the

$3.00 amount in 29(a) must not be ad-

justed.

Section 29(c)(1) defines the term qual-

ified fuels to include oil produced from

shale and tar sands; gas produced from

geopressurized brine, Devonian shale, coal

seams, or a tight formation, or biomass;

and liquid, gaseous, or solid synthetic fu-

els produced from coal (including lignite),including such fuels when used as feed-

stocks.

Section 29(d)(1) provides that the credit

is to be applied only for sale of qualified

fuels the production of which is within

the United States (within the meaning of

638(1)) or a possession of the United

States (within the meaning of 638(2)).

Section 29(d)(2)(A) requires that the

Secretary, notlater than April 1 of each cal-

endar year, determine and publish in the

Federal Register the inflation adjustment

factor and the reference price for the pre-

ceding calendar year.

Section 29(d)(2)(B) defines inflation

adjustment factor for a calendar year as

the fraction the numerator of which is the

GNP implicit price deflator for the calen-

dar year and the denominator of which is

the GNP implicit price deflator for calen-

dar year 1979. The term GNP implicit

price deflator means the first revision of

the implicit price deflator for the gross na-

May 3, 2004 847 2004-18 I.R.B.


10/47

tional product as computed and published

by the Department of Commerce.

Section 29(d)(2)(C) defines reference

price to mean with respect to a calendar

year the Secretarys estimate of the annual

average wellhead price per barrel for all

domestic crude oil the price of which is not

subject to regulation by the United States.

Section 29(d)(3) provides that in the

case of a property or facility in which more

than one person has an interest, except

to the extent provided in regulations pre-

scribed by the Secretary, production from

the property or facility (as the case may

be) must be allocated among the persons

in proportion to their respective interests in

the gross sales from the property or facil-

ity.

Section 29(d)(5) provides that the term

barrel-of-oil equivalent with respect to

any fuel generally means that amount of

the fuel which has a Btu content of 5.8million.

INFLATION ADJUSTMENT FACTOR

AND REFERENCE PRICE

The inflation adjustment factor for cal-

endar year 2003 is 2.1336. The reference

price for calendar year 2003 is $27.56.

These amounts will be published in the

Federal Register on April 7, 2004.

PHASEOUT CALCULATION

Because the calendar year 2003 refer-ence price does not exceed $23.50 mul-

tiplied by the inflation adjustment factor,

the phaseout of the credit provided for in

29(b)(1) does not occur for any qualified

fuel sold in calendar year 2003.

CREDIT AMOUNT

The nonconventional source fuel credit

under 29(a) is $6.40 per barrel-of-oil

equivalent of qualified fuels ($3.00 x

2.1336). This amount will be published in

the Federal Register on April 7, 2004.


CONTACT

The principal author of this notice is

Jaime Park of theOffice of AssociateChief

Counsel (Passthroughs and Special Indus-

tries). For further information regarding

this notice, contact Ms. Park at (202)

6223120 (not a toll-free call).

Weighted Average InterestRate Modification

Notice 200434

This notice provides guidance as to

the determination of the weighted average

interest rate and the resulting permissible

range of interest rates used to calculatecurrent liability for the purpose of the

additional funding requirements under

412(l) of the Internal Revenue Code

and the minimum full funding limitation

of 412(c)(7)(E) of the Code, the cor-

responding requirements and limitation

under 302(c)(7)(E) and 302(d) of the

Employee Retirement Income Security

Act of 1974 (ERISA). In addition, this

notice sets forth the interest rate under

4006(a)(3)(E)(iii)(V) of ERISA, which

is needed in the determination of unfunded

vested benefits for purposes of determin-ing premiums payable to the Pension

Benefit Guaranty Corporation (PBGC).

This notice implements changes to the

rules regarding those interest rates that

were enacted in section 101 of the Pension

Funding Equity Act of 2004, P.L. 108-218.

BACKGROUND AND PRIOR LAW

Under 412(b)(5)(A) of the Code,

the funding standard account (and items

therein) must be charged or credited with

interest at the appropriate rate consistentwith the rate or rates of interest used under

the plan to determine costs.

Section 412(b)(5)(B) provides special

rules for the interest rate that is used to

determine a plans current liability for

purposes of 412(l) and for purposes of

the minimum full funding limitation under

412(c)(7)(E). In general, that interest

rate must fall within a specified corridor

based on the weighted average of the rates

of interest on 30-year Treasury constant

maturities during the 4-year period ending

on the last day before the beginning ofthe plan year, as published monthly in the

Internal Revenue Bulletin. See Notice

8873, 19882 C.B. 383. Under Notice

200226, 20021 C.B. 743, the interest

rate used in determining the weighted av-

erage interest rate currently is based on

the yield on the 30-year Treasury bonds

maturing in February 2031.

In general, 412(l)(7)(C)(i)(II) speci-

fies that, for years after 1998, the interest

rate used to determine the deficit reductio

contribution must be not more than 105%

of the weighted average interest rate. A

special rule for 2002 and 2003 was enacte

in the Job Creation and Worker Assistanc

Act of 2002 (Pub. L. No. 107147, 11

Stat. 21) to provide for the deficit reduc

tion contribution under 412(l) to be cal

culated using a corridor capped at 120%

of the weighted average interest rate rathe

than 105% of the weighted average inter

est rate.

PENSION FUNDING EQUITY ACT OF

2004

The Pension Funding Equity Act wa

enacted on April 10, 2004. Sectio

412(b)(5)(B)(ii)(II) of the Code, whic

was added by section 101 of the Pensio

Funding Equity Act, provides that, fo

plan years beginning in 2004 and 2005

the interest rate used to determine currenliability must not be above and must not b

more than 10 percent below the weighted

average of the rates of interest on amount

invested conservatively in long-term in

vestment-grade corporate bonds durin

the 4-year period ending on the last da

before the beginning of the plan year. Un

der 412(b)(5)(B)(ii)(II), the Treasur

Department must prescribe a method fo

periodically determining the rates. Thes

rates must be based on the use of two

or more indices that are in the top thre

quality levels available. The Treasur

Department must make the permissibl

range, and the indices and methodolog

used to determine the average rate, pub

licly available.

Section 412(l)(7)(C)(i)(IV), which wa

also added by the Pension Funding Equity

Act, provides that, for plan years begin

ning in 2004 and 2005, the interest rat

used to determine current liability for pur

poses of determining the deficit reduction

contribution must be the same as the rat

used under 412(b)(5).

INTERIM GUIDANCE

This notice provides interim guid

ance on the determination of th

weighted average interest rate unde

412(b)(5)(B)(ii)(II) of the Code an

302(b)(5)(B)(ii)(II) of ERISA. I

addition, this notice provides interim

guidance as to the interest rate unde

4006(a)(3)(E)(iii)(V) of ERISA, whic

2004-18 I.R.B. 848 May 3, 200


11/47

is needed in the determination of unfunded

vested benefits for purposes of determin-

ing premiums payable to the PBGC. Tax-

payers can rely on this interim guidance

until the publication of further guidance.

Any further guidance will not apply to plan

years beginning before the publication of

further guidance. The determination of

the weighted average involves: a speci-

fication of the indices; the determination

of the rate of interest on amounts invested

conservatively in investment-grade corpo-

rate bonds (the composite corporate bond

rate); and the determination of a 4-year

weighted moving average of the compos-

ite corporate bond rate (the corporate

weighted average interest rate).

Specification of Indices

The following indices are designated

for use in determining composite corporate

bond rates beginning with January 1997and ending August 2000.

1. Citigroup High Grade Corporate In-

dex (AAA/AA, 10+ Years)

2. Merrill Lynch US Corporates

AA-AAA Rated 10+ Years

3. Merrill Lynch US Corporates A

Rated 15+ Years

The following indices are designated

for use in determining the composite cor-

porate bond rates beginning with Septem-

ber 2000 and continuing until further guid-

ance is issued:

1. Citigroup High Grade Credit Index1

(AAA/AA, 10+ Years)

2. Merrill Lynch US Corporates

AA-AAA Rated 10+ Years

3. Lehman Brothers US A Long Credit

All of these indices reflect interest rates on

long-term corporate bonds that are in the

top three quality levels.

Composite Corporate Bond Rate

The composite corporate bond rate for

a month is determined using the indicesdesignated in this notice. For each in-

dex designated for inclusion in determin-

ing the composite corporate bond rate for a

month, a monthly rate is determined based

on the average of the daily values for the

yield to maturity for the bonds that are in-

cluded in the index, as determined by the

financial service firm maintaining the in-

dex. The composite corporate bond rate

for the month is determined by computing

the average of these monthly rates. Table 1

lists the composite corporate bond rates for

the months January 2000 through March

2004.

Corporate Weighted Average Interest

Rate and Section 412(b)(5)(B)(ii)(II)

Permissible Range

The corporate weighted average in-

terest rate under 412(b)(5)(B)(ii)(II)

for a month is determined by applying

the weighting methodology set forth in

Notice 8873 to the composite corporate

bond rates for the 48 months preced-

ing that month. Thus, in determining

the 48-month weighted average of the

composite corporate bond rate, the com-

posite corporate bond rate for each of the

months within the immediately preceding

12 months receives a weight of 4, thosethat are 1324 months in the past receive

a weight of 3, those that are 2536 months

in the past receive a weight of 2 and those

that are 37 or more months before the

determination receive a weight of 1. The

412(b)(5)(B)(ii)(II) permissible range is

90% to 100% of the corporate weighted

average interest rate. Table 2 lists the

corporate weighted average interest rates

and the permissible range for plan years

beginning in the months January 2001

through April 2004.

Lookback Rules

Under section 101(d)(2) of the Pension

Funding Equity Act of 2004, for purposes

of applying section 412(l)(9)(B)(ii) and

section 412(m)(1) of the Code (and section

302(d)(9)(B)(ii) and section 302(m)(1) of

ERISA) to plan years beginning after De-

cember 31, 2003, the amendments made

by section 101 of the Pension Funding

Equity Act of 2004 may be applied as if

such amendments have been in effect for

all prior years. Thus, for example, forthe plan year beginning January 1, 2004,

in determining whether the plans funded

current liability percentage was at least

90 percent for two consecutive years of

the previous three years under section

412(l)(9)(B)(ii), the funded current liabil-

ity percentage may be recalculated using

the corporate weighted average interest

rate applicable for plan years beginning in

January 2001, 2002, and 2003. Similarly,

in determining whether a plan is subject

to quarterly contributions under section

412(m)(1) for the plan year beginning Jan-

uary 1, 2004, the funded current liability

percentage for 2003 may be recalculated

using the corporate weighted average in-

terest rate.

However, for purposes of computing

the required installment under section

412(m)(4) for plan years beginning in

2004, the required amount for plan years

beginning in 2003 may not be recalculated

using the corporate weighted average in-

terest rate. Instead, the required amount

for 2003 will continue to be determined

based upon an interest rate which is within

the range of 90 to 120 percent of the

weighted average of the rate of interest on

30-year Treasury securities.

Monthly Publication of Rates

The IRS will publish by notice each

month the composite corporate bond rate,

the corporate weighted average interest

rate, and the 412(b)(5)(B)(ii)(II) permis-

sible range. The same notice will specify

a change in the group of indices that are

taken into account in determining the

component corporate bond rate, and the

manner they are taken into account, if any

such change takes place.

Request for Comments

Comments are requested regarding

the determination of the composite cor-

porate bond rate set forth in this notice.

Specifically, comments are requested re-

garding the appropriateness of the indices

that are used in the determination of this

rate, whether other indices would be more

appropriate for this purpose, and the ap-

propriateness of the weight given to each

index.

Comments should be submitted by Au-

gust 2, 2004, to CC:PA:LPD:RU (Notice200434), Room 5203, Internal Rev-

enue Service, POB 7604, Ben Franklin

Station, Washington, D.C. 20044. Com-

ments may be hand delivered between

the hours of 8 a.m. and 5 p.m., Mon-

day through Friday to CC:PA:LPD:RU

(Notice 200434), Couriers Desk, Inter-

nal Revenue Service, 1111 Constitution

1 The name of the Citigroup High Grade Corporate Index was changed to the Citigroup High Grade Credit Index in April 2001, when a new Citigroup High Grade Corporate Index was created.

May 3, 2004 849 2004-18 I.R.B.


12/47

Ave., NW, Washington D.C. Alternatively,

comments may be submitted electroni-

cally via e-mail to the following address:

[email protected],

with Notice 200434 in the subject line.

All comments will be available for public

inspection.


The principal author of this notice is

Tony Montanaro of the Employee Plans,

Tax Exempt and Government Entities Di-

vision. For further information regarding

this notice, please contact the Employee

Plans taxpayer assistance telephone ser-

vice at 18778295500 (a toll-free num

ber), between the hours of 8:00 a.m. an

6:30 p.m. Eastern time, Monday throug

Friday. Mr. Montanaro may be reached a

12022839714 (not a toll-free number)

Table 1

Composite Corporate Bond Rates

Composite Rates for:

Month 2000 2001 2002 2003 2004

January 7.94 7.34 6.92 6.07 5.68February 7.84 7.21 6.86 5.90 5.63March 7.87 7.08 7.10 5.89 5.44

April 7.84 7.28 7.03 5.91May 8.27 7.28 6.99 5.42

June 8.05 7.17 6.76 5.24

July 7.93 7.13 6.74 5.77August 7.82 6.95 6.57 6.19September 7.87 7.05 6.27 5.95

October 7.85 6.91 6.47 5.91November 7.82 6.82 6.30 5.86December 7.51 7.07 6.18 5.81

Table 2

Corporate Bond Weighted Average Interest Rates

CorporateBond

For Plan Years Beginning in: Weighted Permissible RangeYear Month Average 90% 100%

2001 January 7.44 6.69 7.442001 February 7.44 6.69 7.442001 March 7.44 6.69 7.442001 April 7.43 6.68 7.432001 May 7.42 6.68 7.422001 June 7.42 6.68 7.42

2001 July 7.41 6.67 7.412001 August 7.40 6.66 7.402001 September 7.39 6.65 7.392001 October 7.37 6.64 7.372001 November 7.36 6.62 7.362001 December 7.34 6.61 7.34


2004-18 I.R.B. 850 May 3, 200


13/47

Table 2

Corporate Bond Weighted Average Interest RatesContinued

CorporateBond

For Plan Years Beginning in: Weighted Permissible RangeYear Month Average 90% 100%




2004 January 6.55 5.89 6.552004 February 6.50 5.85 6.502004 March 6.45 5.81 6.452004 April 6.40 5.76 6.40

May 3, 2004 851 2004-18 I.R.B.


14/47

Part IV. Items of General Interest

Notice of ProposedRulemaking and Notice ofPublic Hearing

Modification of Check the Box

REG10668102

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking

and notice of public hearing.

SUMMARY: This document contains pro-

posed regulations that clarify that qualified

REIT subsidiaries, qualified subchapter S

subsidiaries, and single owner eligible en-

tities that are disregarded as entities sepa-

rate from their owners are treated as sepa-rate entities for purposes of any Federal tax

liability for which the entity is liable. This

document also provides notice of a public

hearing.

DATES: Written or electronic comments

must be received by June 30, 2004. Out-

lines of topics to be discussed at the pub-

lic hearing scheduled for July 22, 2004, at

10:00 a.m., must be received by July 1,

2004.

ADDRESSES: Send submissions to:CC:PA:LPD:PR (REG10668102), room

5203, Internal Revenue Service, POB

7604, Ben Franklin Station, Washing-

ton, DC 20044. Submissions may be

hand delivered Monday through Friday

between the hours of 8 a.m. and 4 p.m.

to: CC:PA:LPD:PR (REG10668102),

Couriers Desk, Internal Revenue Ser-

vice, 1111 Constitution Avenue, NW,

Washington, DC. Alternatively, tax-

payers may submit electronic com-

ments directly to the IRS internet site

at http://www.irs.gov/regs. The publichearing will be held in the Auditorium,

Internal Revenue Building, 1111 Constitu-

tion Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION

CONTACT: Concerning the proposed

regulations, James M. Gergurich, (202)

6223070; concerning submissions

and the hearing, Treena Garrett, (202)

6227180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

Under the Internal Revenue Code and

its regulations, three types of entities may

be disregarded as entities separate from

their owners: qualified REIT subsidiaries(within the meaning of section 856(i)(2)),

qualified subchapter S subsidiaries (within

the meaning of section 1361(b)(3)(B)), and

single owner eligible entities (within the

meaning of 301.77013(a)) (each, a dis-

regarded entity).

Section 856(i)(1) provides that a qual-

ified REIT subsidiary (QRS) shall not be

treated as a separate corporation. Under

section 856(i)(2), a QRS is defined as any

corporation 100 percent of the stock of

which is held by a real estate investment

trust (REIT), unless the REIT and the cor-

poration jointly elect under section 856(l)

that the corporation shall be treated as a

taxable REIT subsidiary. Such election

may be revoked at any time with the con-

sent of both the corporation and the REIT.

Section 1361(b)(3)(A) similarly pro-

vides that a qualified subchapter S cor-

poration (QSub) shall not be treated as

a separate corporation. Under section

1361(b)(3)(B), a QSub is defined as any el-

igible domestic corporation that is wholly

owned by an S corporation and that the Scorporation elects to treat as a QSub.

In addition, under 301.77013(b)(1)

and (2), an eligible entity with a sin-

gle owner may be disregarded as an

entity separate from its owner. Sec-

tion 301.77013(b)(1)(ii) provides that

a domestic eligible entity with a sin-

gle owner is disregarded unless the en-

tity makes an election to be classified

as an association (and thus a corpora-

tion under 301.77012(b)(2)). Section

301.77013(b)(2)(C) provides that a for-

eign eligible entity with a single ownerthat does not have limited liability is

disregarded unless the entity elects to

be classified as a corporation. Under

301.77013(c), a single owner eligible

entity that has elected to be treated as a cor-

poration and a foreign eligible entity with

a single owner that has limited liability

(that would otherwise be treated as a cor-

poration under 301.77013(b)(2)(i)(B))

may elect, subject to certain limitations, t

be disregarded.

Explanation of Provisions

As described above, a taxable entit

may become disregarded in a variety of cir

cumstances. For example, if a REIT acquires all of the stock of a corporation, th

corporation will become a QRS that is no

treated as a separate corporation. Like

wise, an S corporation may elect to trea

a wholly owned eligible domestic corpo

ration as a QSub that is not treated as a

separate corporation. It is also possible fo

a disregarded entity to be the survivor o

a merger of a taxable entity (for example

a corporation) and the disregarded entity

Although a disregarded entity generally i

not liable for Federal tax liabilities of it

owner with respect to taxable periods dur

ing which it is disregarded, the disregarde

entity may be liable for Federal taxes wit

respect to taxable periods during which i

was not disregarded or because it is th

successor or transferee of a taxable entity

The proposed regulations do not ad

dress the question of whether the disre

garded entity is, in fact, either liable fo

Federal taxes or entitled to a refund o

credit of Federal tax. Rather, the regu

lations clarify that if a disregarded entity

is liable for Federal taxes, the disregardeentity will be treated as an entity separat

from its owner for purposes of those lia

bilities, such that assessment may be mad

against the disregarded entity, the assets o

the disregarded entity may be subject to

lien and levy, and the disregarded entity

may consent to extend the period of limita

tions on assessment. In addition, the regu

lations clarify that if a disregarded entity i

entitled to a refund or credit of Federal tax

the disregarded entity will be treated as a

entity separate from its owner for purpose

of that refund or credit.

Proposed Effective Date

These regulations are proposed to appl

on or after April 1, 2004.

Special Analyses

It has been determined that this notic

of proposed rulemaking is not a significan

regulatory action as defined in Executiv

2004-18 I.R.B. 852 May 3, 200


15/47

Order 12866. Therefore, a regulatory as-

sessment is not required. It also has been

determined that section 553(b) of the Ad-

ministrative Procedure Act (5 U.S.C. chap-

ter 5) does not apply to these regulations

and, because the regulations do not im-

pose a collection of information on small

entities, the Regulatory Flexibility Act (5

U.S.C. chapter 6) does not apply. There-

fore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f)

of the Code, these regulations will be sub-

mitted to the Chief Counsel for Advocacy

of the Small Business Administration for

comment on its impact on small business.

Comments and Public Hearing

Before this proposed regulation is

adopted as a final regulation, considera-

tion will be given to any written (a signed

original and (8) copies) or electronic com-ments that are submitted timely to the IRS.

The IRS and Treasury Department request

comments on the clarity of the proposed

rules and how they can be made easier to

understand. All comments will be avail-

able for public inspection and copying.

A public hearing has been scheduled

for July 22, 2004, at 10:00 a.m., in the Au-

ditorium, Internal Revenue Building, 1111

Constitution Avenue, NW, Washington,

DC. Due to building security procedures,

visitors must enter at the Constitution Av-

enue entrance. In addition, all visitorsmust present photo identification to enter

the building. Because of access restric-

tions, visitors will not be admitted beyond

the immediate entrance area more than 30

minutes before the hearing starts. For in-

formation about having your name on the

building access list to attend the hearing,

see the FOR FURTHER INFORMATION

CONTACT portion of this preamble. The

rules of 26 CFR 601.601(a)(3) apply to

the hearing. Persons who wish to present

oral comments must submit written or

electronic comments by June 30, 2004,and an outline of the topics to be discussed

and the time to be devoted to each topic

(a signed original and eight (8) copies) by

July 1, 2004. A period of 10 minutes will

be allotted to each person for making com-

ments. An agenda showing the scheduling

of the speakers will be prepared after the

deadline for receiving outlines has passed.

Copies of the agenda will be available free

of charge at the hearing.


The principal author of these regu-

lations is James M. Gergurich of the

Office of the Associate Chief Counsel

(Passthroughs & Special Industries), IRS.

However, other personnel from the IRS

and Treasury participated in their devel-

opment.

* * * * *

Proposed Amendments to the

Regulations

Accordingly, 26 CFR parts 1 and 301

are proposed to be amended as follows:

PART 1INCOME TAX

Paragraph 1. The authority citation for

part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.8569 is added to readas follows:

1.8569 Treatment of certain qualified

REIT subsidiaries.

(a) In general. A qualified REIT sub-

sidiary, even though it is otherwise not

treated as a corporation separate from the

REIT, is treated as a separate corporation

for purposes of:

(1) Federal tax liabilities of the quali-

fied REIT subsidiary with respect to any

taxable period for which the qualifiedREIT subsidiary was treated as a separate

corporation.

(2) Federal tax liabilities of any other

entity for which the qualified REIT sub-

sidiary is liable.

(3) Refunds or credits of Federal tax.

(b) Examples. The following examples

illustrate the application of paragraph (a)

of this section: Example 1. X, a calendar year taxpayer, is a do-

mestic corporation 100 percent of the stock of which

is acquired by Y, a real estate investment trust, in

2002. X was not a member of a consolidated group at

any time during its taxable year ending in December

2001. Consequently, X is treated as a qualified REIT

subsidiary under the provisions of section 856(i). In

2004, the Internal Revenue Service (IRS) seeks to

extendthe periodof limitations on assessment forXs

2001 taxable year. Because X was treated as a sep-

arate corporation for its 2001 taxable year, X is the

proper party to sign the consent to extend the period

of limitations.

Example 2. The facts are the same as in Exam-

ple 1, except that upon Ys acquisition of X, Y and X

jointly elect under section 856(l) to treat X as a tax-

able REIT subsidiary of Y. In 2003, Y and X jointly

revoke that election. Consequently, X is treated as

a qualified REIT subsidiary under the provisions of

section 856(i). In 2004, the IRS determines that X

miscalculated and underreported its income tax lia-

bility for 2001. Because X was treated as a separate

corporation for its 2001 taxable year, the deficiency

may be assessed against X and, in the event that X

fails to pay the liability after notice and demand, a

general tax lien will arise against all of Xs property

and rights to property.

Example 3. X is a qualified REIT subsidiary of Yunder the provisions of section 856(i). In 2001, Z, a

domestic corporation that reports its taxes on a calen-

dar year basis, merges into X in a state law merger. Z

wasnot a memberof a consolidated group at any time

duringits taxable year endingin December 2000. Un-

der the applicable state law, X is the successor to Z

and is liable for all of Zs debts. In 2004, the IRS

seeks to extend the period of limitations on assess-

ment for Zs 2000 taxable year. Because X is the

successor to Z and is liable for Zs 2000 taxes that

remain unpaid, X is the proper party to sign the con-

sent to extend the period of limitations.

(c) Effective date. This section applies

on or after April 1, 2004.

Par. 3. Section 1.13614 is amended asfollows:

1. In paragraph (a)(1), the first sen-

tence is amended by adding the language

and (a)(6) immediately following the

language Except as otherwise provided

in paragraph (a)(3).

2. Paragraph (a)(6) is added.

The addition reads as follows:

1.13614 Effect of Qsub election.

(a) * * * (1) * * *

(6) Treatment of certain QSubs(i) Ingeneral. A QSub, even though it is gen-

erally not treated as a corporation separate

from the S corporation, is treated as a sep-

arate corporation for purposes of:

(A) Federal tax liabilities of the QSub

with respect to any taxable period for

which the QSub was treated as a separate

corporation.

(B) Federal tax liabilities of any other

entity for which the QSub is liable.

(C) Refunds or credits of Federal tax.

(ii) Examples. The following exam-

ples illustrate the application of paragraph(a)(6)(i) of this section:

Example 1. X has owned all of the outstanding

stock of Y, a domestic corporation that reports its

taxes on a calendar year basis, since 2001. X and

Y do not report their taxes on a consolidated basis.

For 2003, X makes a timely S election and simulta-

neously makes a QSub election for Y. In 2004, the

Internal Revenue Service (IRS) seeks to extend the

period of limitations on assessment for Ys 2001 tax-

able year. Because Y was treated as a separate corpo-

ration for its 2001 taxable year, Y is the proper party

to sign the consent to extend the period of limitations.

May 3, 2004 853 2004-18 I.R.B.


16/47


17/47

Angelos Choral Mission Group,

Salinas, CA

Animal Assistance and Education League

an International, Aurora, CO

Arena of Hope, Blackfoot, ID

Arizona Abstinence Alliance, Inc.,

Chandler, AZ

Arizona Childrens Alliance of Southern

Apache County, Springville, AZ

Arizona Employer Support of the Guard

and Reserve, Tucson, AZ

Arizona Hate Crime Advisory Board,

Inc., Phoenix, AZ

Arizona Peak Performance Volleyball

Club, Scottsdale, AZ

Arizona Traffic Investigators Association,

Chandler, AZ

Arrive Alive, Inc., Las Vegas, NV

Asian Pacific American Police

Association, Las Vegas, NV

Athletics Instead of Depression and

Sickness, Inc., Santa Barbara, CAAutonomy House, Incorporated,

Salt Lake City, UT

Azores Relief Fund, San Jose, CA

Aztec Wrestling Club, Tucson, AZ

B & C Ranch School, Inc.,

Koosharem, UT

Baby Steps Developmental Series, Inc.,

Lake Havasu City, AZ

Bakersfield Aid Project, Bakersfield, CA

Balkan Humanitarian Society,

Las Vegas, NV

Ballet Contempo, Inc., Santa Barbara, CA

Bango, Carnation, WABasketball Academy of Texas, Inc.,

Alexandria, VA

Bay Area Circus Center,

Mountain View, CA

Because Education Matters, Houston, TX

Bellaire High School JROTC Parents

Club, Bellaire, TX

Bethesda House, Inc., Bacliff, TX

Better a Millstone, Inc., A Nevada Corp.,

Monterey, CA

Bibles for Jails Project, Lakewood, CO

Big River Soccer Club, E. Wenatchee, WA

Bill Crowles Sr. Supportive Services,Bakersfield, CA

Black & Whaley Enterprises,

Los Angeles, CA

Blaine County Search & Rescue, Inc.,

Chinook, MT

Bonner County EMS Advisory Board,

Ponderay, ID

Books for Belize, Inc., St. Petersburg, FL

Border Collie Rescue Texas, Inc.,

Houston, TX

Boulder Valley Wrestling Club,

Boulder, CO

Bourland Trestle Partnership,

Groveland, CA

Boys & Girls Club of Tri-County, Inc.,

Helena, MT

Boys and Girls Club of Cottonwood,

Cottonwood, AZ

Bradams, Inc., Gallup, NM

Bright Wings, Inc., Durango, CO

Brighton Bombers Baseball,

Ft. Lupton, CO

Building Families Foundation, Ogden, UT

Butte Youth Traveling Basketball

Association, Butte, MT

Bypac, Inc., Breckenridge, CO

Caddie Foundation of Arizona,

Glendale, AZ

California Space, Incorporated,

Santa Maria, CA

California Taekwondo Junior Olympic

Team, San Jose, CACardoza Foundation, Modesto, CA

Carson City Urban Indian Consortium,

Inc., Carson City, NV

Cascade Assistance Dogs Educational

Training Center, Inc., Bow, WA

Cascade Community Childrens Fund,

Eugene, OR

Cascade Rowing, Seattle, WA

Cass Kids Farm Safety, Kindred, ND

Cat Hoop Club, Carmel, CA

Center for Mission Education, Denver, CO

Center for Nanospace Technologies,

League City, TXCenter for the Arts in Telluride, Ophir, CO

Center for the Study of Biodiversity and

Ecosystems, Las Vegas, NV

Center for Transformational Healing,

Tucson, AZ

Central Valley Group Home and Family

Services, Inc., Modesto, CA

CFHS Touchdown Club, Tucson, AZ

Charter, Inc., Denver, CO

Chatham-Meier Foundation,

Claremont, CA

Cheyenne Childrens Museum,

Cheyenne, WYChildrens Brain Tumor Research

& Family Relief Foundation,

Redmond, WA

Childrens Charities International,

Walnut Creek, CA

Childrens Field, Tijeras, NM

Childrens Place Child Care &

Early Learning Foundation, Inc.,

Sugar City, ID

Chimayo Youth Center, Chimayo, NM

Choteau Baseball Commission, Inc.,

Choteau, MT

Christian Drug Education Center,

Westminster, CO

Citizens Institute for Voter Information in

Colorado, Vermillion, SD

Clarence Project, Bellevue, WA

Clothesminded, Inc., Tempe, AZ

Coeur Dalene Area Swim Team, Inc.,

Post Falls, ID

Collegiate Broadcast Network,

Denver, CO

Colorado Arts and Crafts Society,

Golden, CO

Colorado Christian Community Fund,

Wheat Ridge, CO

Colorado Clinical Guidelines

Collaborative, Denver, CO

Colorado Girls Awesome Softball

Association CGASA, Denver, CO

Colorado Mule Deer Association,

Grand Junction, COColorado Organization Development

Network, Englewood, CO

Colorado Prairie Preserve, Inc.,

Boulder, CO

Colorado Springs Racquet Club Swim

Team, Inc., Colorado Springs, CO

Colorado Springs Youth Cycling,

Colorado Springs, CO

Colorado Youth Center for Alternative

Sports, Inc., Fort Collins, CO

Columbia Public Interest Policy Institute,

Bellevue, WA

Communities United for SustainableProgress, Atascadero, CA

Community for the Advancement of

Family Education, Wenatchee, WA

Community Group Homes, Fresno, CA

Community Prevention Services,

Salt Lake City, UT

Community Technical Services, Inc.,

Las Vegas, NV

Community Wellness Alliance,

Palo Alto, CA

Computer Literacy Resources, Inc.,

Prescott, AZ

Confluence Art Center, Winthrop, WAConifer High School Instrumental Music

Boosters, Inc., Conifer, CO

Creating New Life Ministries, Inc.,

Houston, TX

Creative Alternatives for Resolution Ent.,

Fresno, CA

Credo International, Monroe, WA

Cripple Creek-Victor and Canon

City Railroad Museum, Inc.,

Cripple Creek, CO

May 3, 2004 855 2004-18 I.R.B.


18/47

Cross Streets, Tucson, AZ

CTD Resource Network, Inc.,

Los Banos, CA

CUPIG Acres, Inc., Sedona, AZ

Damas Dog Foundation, Inc., Rigby, ID

Dancevision, Fort Collins, CO

Danssa Brasil, Thousand Oaks, CA

Dasira Narada Human Energy Studies

Foundation, Milpitas, CA

Dateland Historical and Military Museum,

Sun City, AZ

David Nathan Blanco Foundation,

Carson, CA

De Colores Foundation, Chula Vista, CA

Deer Park Enterprise, Lyons, CO

Denver Athletic Club Scholarship Fund,

Denver, CO

Denver Latino International Film Festival,

Denver, CO

Deron A. Dickman Legacy Foundation,

Salt Lake City, UT

Dirtworks, Livingston, MTDome of Hope Organization, Inc.,

Stockton, CA

Don Carlos Communities, Inc.,

Concord, CA

Dreamskate, Kirkland, WA

Dubrovnik Inter University

Centre Educational Foundation,

Santa Barbara, CA

Eagle Rock Transport, Idaho Falls, ID

Earth-People Foundation, Inc.,

Sedona, AZ

Eastside Rays, Brier, WA

Ecoforestry Services for Farmers,Arcata, CA

Education for Excellence,

Redondo Beach, CA

EFA Private Funding, Inc., Payette, ID

El Bienestar De Familias,

Tira Amarilla, NM

El Pueblo, Palo Alto, CA

Elder Heart Foundation, Inc., Phoenix, AZ

Elite Health Care Systems, Inc.,

San Jose, CA

Elko Emergency Services Chaplains,

Elko, NV

Eloha Foundation, Kalaheo, HIEmergence the American Indian Credit

Association, Inc., E. Glacier, MT

Emergency Management Foundation of

Spokane, Spokane, WA

Equity First Credit Foundation,

Salt Lake City, UT

Esther Korson Ministries, Inc.,

Phoenix, AZ

Eud-Ktv Productions, Houston, TX

Evergreen Search Dogs, Vancouver, WA

Excel Foundation for the Advancement of

Societal Causes, Camarillo, CA

Eye Heritage Organization, Inc.,

Houston, TX

Fairfield Emergency Medical Services

Association, Fairfield, MT

Faith Alive Christian Center, Inc.,

Las Vegas, NV

Family Support Services, Vancouver, WA

Fathers House of Victory Threw the Holy

Family, Inc., Santa Maria, CA

Feline Lovers Lodge, Tucson, AZ

Fia Kay House, Spokane, WA

F I G L E A F Educational Festivals,

Fresno, CA

Financial Health and Fitness Foundation,

Inc., Evanston, WY

First Judicial District Bar Association

Legal Assistance Program,

Lakewood, CO

First National Fire Service Incident

Management System Consortium,Deer Park, TX

Fish Forever, Gwynn Oak, MD

Flames of Glory, Colorado Springs, CO

Flathead Watershed Residents for

Responsible Development, Polson, MT

Foothills Childrens Foundation,

Cave Creek, AZ

For Fun and for Free, Flagstaff, AZ

Foundation for Fair Campaign Reporting,

Kirkland, WA

Foundation for Handicapped

Entrepreneurs, Westminster, CO

Free Spirit Community Services Program,Inc., Modesto, CA

Fresh Start Childrens Services,

Aurora, CO

Friends of Bear Creek Redwoods Region

Preserve, Los Gators, CA

Friends of Feral Felines, Searchlight, NV

Friends of Kiel Ranch Historic Site,

North Las Vegas, NV

Friends of Meadowdale High School,

Edmonds, WA

Friends of River Oaks Park, Houston, TX

Friends of the Children, Bakersfield, CA

Friends of the Ogden Eccles ConferenceCenter, Ogden, UT

Friends of Wasatch State Park, Inc.,

Midway, UT

Fuente Ballet of New Mexico, Inc.,

Albuquerque, NM

Function 1 Foundation, Inc.,

Las Cruces, NM

Fund Raiser, Inc., Las Vegas, NV

Fusion Dance Troupe, Seattle, WA

Future Leaders, Inc., Visalia, CA

Galveston Mainland Dmat, Inc.,

La Marque, TX

Garnered Grain, Elk Ridge, UT

Gate City Volleyball Club, Pocatello, ID

Gathering of the Governors, Seattle, WA

Girls on the Go Foundation, Boulder, CO

Global Cultural & Arts, Inc.,

San Mateo, CA

Global Interactive Educational

Adventures, Boulder, CO

Global Learning & Observations to

Benefits the Environment New Mexico

Sante Fe, NM

Gloriana, Inc., of Colorado, Tacoma, WA

God Help Rebuilding Broken Lives, Inc.

Beverly Hills, CA

Gods G I F T Ministries, Scottsdale, AZ

Golden Empire Football League,

Bakersfield, CA

Golf Academy of the Southwest,

Rio Rancho, NM

Good Shepherd Learning Center,Phoenix, AZ

Good Soil Ministry, Everett, WA

Goodhope Community Clinic,

Houston, TX

Gospel Power Ministries, Inc.,

Lancaster, CA

Great Commission Broadcasting

Company, Inc., Meeker, CO

Great Falls Elks Lod